Greetings. Welcome to the K12 Second Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Mike Kraft. Thank you. You may begin.

Thank you, and good afternoon. Welcome to K12's Second Quarter Earnings Call for fiscal year 2020. Before we begin, I'd like to remind you that in addition to historical information, certain comments made during this conference call may be considered forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. They should be considered in conjunction with cautionary statements contained in our earnings release and the company's periodic filings with the SEC. Forward-looking statements involve risks and uncertainties that may cause actual performance or results to differ materially from those expressed or implied by such statements. In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the day of this live call. K12 does not undertake any obligation to publicly update or revise any forward-looking statements. For further information concerning risks and uncertainties that could materially affect financial and operational performance and results, please refer to our reports filed with the SEC. These reports include, without limitation, cautionary statements made in K12's 2019 annual report on Form 10-K. These filings can be found on the Investor Relations section of our website at www.k12.com. In addition to disclosing financial results in accordance with generally accepted accounting principles in the U.S. or GAAP, we will discuss certain information that is considered non-GAAP financial information. A reconciliation of this non-GAAP financial information to the most closely comparable GAAP information was included in our earnings release and is also posted on our website. This call is open to the public and is being webcast. The call will be available for replay for 30 days. With me on today's call is Nate Davis, Chief Executive Officer and Chairman of the Board; and James Rhyu, Chief Financial Officer and President, Product and Technology. Additionally, we are joined by Dr. Shaun McAlmont, President of Career Readiness Education; and Harsh Patel, Chief Executive Officer of Galvanize, who will be available to answer questions following our prepared remarks. I would like now to turn the call over to Nate. Nate?

Thank you, Mike. Good afternoon, everyone, and thanks for joining our quarterly call. I'd like to devote most of my time to providing details about the announcement we made earlier today, K12's acquisition of tech pioneer Galvanize. I'd like to welcome, Harsh Patel, CEO of Galvanize, to our team, and also welcome him to the call today. Harsh is calling in remotely, and he will participate in our Q&A session, as Mike noted. Let's get going with a brief summary of this quarter's financial results. As you saw in today's press release, revenue was $257.6 million in the second quarter of fiscal year 2020, an increase of 1.1% year-over-year. Tied to our revenue growth, adjusted operating income for the quarter was $36.5 million, and capital expenditures for the quarter were $9.3 million. Note that our revenue, adjusted operating income and capital expenditures for the second quarter of fiscal '20 met or beat the guidance we provided last quarter. These numbers underscore the ongoing strength of our core business. It's also worth noting that excluding the impact of our acquisition, our business is on pace to achieve the full year revenue and adjusted operating income guidance we originally provided. Now let me turn to a discussion of the Galvanize acquisition and our Career Readiness strategy going forward. As most of you have heard me mention before, our Career Readiness initiative allows us to support and prepare students of every age and background for an increasingly competitive job market. According to the U.S. Bureau of Labor Statistics, job growth is expected to create more than 1 million new jobs per year through 2028. At the top of the list for in-demand jobs, now and in the future, are software engineers and data scientists. However, despite the growing demand for these roles, they…

Thank you, Nate. Good afternoon, everybody. First, let me quickly recap our reported results. Revenue for the quarter was $257.6 million, an increase of 1.1% from last year. Adjusted operating income was $36.5 million, a decrease of 2.4%, and capital expenditures were $9.3 million, a decrease of $0.3 million. In each case, as Nate mentioned, these results met or beat the expectations we provided in our guidance last quarter. Our core business continues to perform well and positions us for accelerating growth into next year. And excluding the Galvanize acquisition, we are on track to be well within the guidance ranges we previously provided. More on Galvanize in a minute. Let me turn to our results for the quarter. Revenue from Managed Public School Programs increased $6.8 million or 3% to $229.6 million. This was a result of increases in both enrollment and revenue per enrollment. Enrollment rose 1% year-over-year, and revenue per enrollment rose 2%. For the full year, we expect revenue per enrollment to be roughly flat to last year. Institutional revenues declined 16.2%. This is largely due to the fact that several large general education customers for whom we provided the infrastructure and content have gone out of business or seeing major declines in their business. For the full year, as noted last quarter, the Institutional Business will decline approximately 15% to 18%. Private Pay revenues were $8.6 million and roughly flat from last year. I want to note that for the remainder of the year, we will include the Galvanize's results in the Private Pay line of business. We will be revisiting our external reporting for fiscal '21, and we'll provide more insight into any potential changes in the fourth quarter. Gross margins were 35% and marginally up from our first quarter gross margins. Including the…

[Operator Instructions] Our first question comes from the line of Corey Greendale with First Analysis.

Congratulations on the acquisition. I've got a couple of questions about Galvanize. First of all, how would you describe Galvanize's differentiation versus other boot camp providers in the market?

Well, Corey, this is Nate. Thank you for attending today. I'm going to talk first about the things that attracted me to Galvanize. And then I'm going to ask Harsh to give his description of how it differentiates itself. So first of all, I wanted to find a company that has a student-centered culture. And I think they have that. They're all about outcomes for students. I wanted a company that's large enough to have a proven -- that they can scale. It's critical that we not be stuck with a small company that can't grow. I wanted a company that had shown growth. I wanted a company that had a strong management team, which, I think, this team has. So I think they'll also be able to differentiate themselves. And I wanted somebody who is recognized for high quality. And when we looked on sites that evaluated many of the boot camp companies, they were recommended -- highly recommended because they were already rated very highly in the quality of their [ trinket ]. But Harsh, I think you -- I did that from my perspective. Harsh, I'd love you to say, how do you differentiate yourself in the marketplace.

Thanks, Nate. One of the biggest ways that we differentiate ourselves is the size of the alumni base. I'll give you a quick example. When I look at our alumni packthreads or our alumni communities, the biggest and most frequent message I see in there is, "Hey, we're -- my company is hiring for software engineers or data scientists. Who is interested?" And I mentioned that as a differentiator because not very many places can have a well-engaged, large, 8,000-plus professional network, and that helps with your careers. And network effects are something that helps differentiate Galvanize and Hack Reactor because of the size. We've been around since 2012, one of the earliest in this space, and therefore, alumni size is just larger than most other places. The other thing is when you look at rating sites, one of the differentiators is that Galvanize and Hack Reactor show up amongst the top 5, often top 2 as places to go to learn software engineering and data science. And so from a prospective student perspective, that immediately differentiates us from the tens, if not hundreds, of other competitors or players in this space. Back over to you, Nate. Let me know if there's something you feel like I missed.

I think the only thing that we didn't cover was a high placement rate?

That's right. Galvanize and Hack Reactor both have historically been known to have some of the highest placement rates out of all of the coding boot camps in the space. And we continue to keep that as our #1 focus. At earlier in the call, the majority of our graduates, 85% or more are placed within 6 months. Average starting salaries across the entire nation at $90,000 plus and over 6 figures in the big markets like New York and San Francisco. And the alumni base has a lot to do with that as well as the reputation in the marketplace as being high-quality, generating junior to mostly mid-level engineers when they're coming out.

Good, very helpful. And then my follow-up, and I'll get back in the queue. Nate, you mentioned a number of potential synergies from the acquisition. I was interested in, specifically, if you could say a little bit more about what Galvanize's primary method of customer acquisition are? And whether you see any synergy on that front like marketing the programs to graduates of the existing kind of managed public schools or anything along those lines?

Yes. I'll talk a little bit about this, Harsh, you can elaborate if I miss anything. First of all, there's 2 segments of the marketplace for galvanized. One is the consumer business. And in the consumer business, they use a number of techniques you would have imagined. There's a lot of social contact and recommendation. They do a little bit of web advertising and search names, search engine optimization and marketing. So most of the acquisition for consumers is coming from either social recommendations or coming from the internet. They do very little on-air advertising. As a matter of fact, they don't do any that I know of. So that's the most of how they get their customers. There are -- I don't want to minimize this reference and referrals because that business is pretty big, based on the fact that there are 8,000 alumni, and they recommend others who have gone through the -- who need to go through the same process they've gone through. But in the enterprise business, it is a face-to-face sale. Very, very different. There is a face-to-face workforce that's growing and called directly on corporation to have corporations, give them information about the kinds of specific needs they have, and then they go and train in their boot camps, specifically for what those corporations need. But that's a face-to-face sale, much different than the consumer business. Harsh, anything else you want to add?

No. I think you nailed there. The majority of them come from referrals, word-of-mouth from our alumni, that strong alumni network and the rest of it through digital advertising, digital acquisition online.

Good insight, do you foresee marketing directly to people who are in or graduating from the managed schools or anything along those lines?

Yes, we do. But I want to be clear that this is a pretty intense program. It's 12 weeks, but most of the people who apply the first time, they'll get in the first time. They have to take a few entry-level courses before they really qualify to go to the immersive intense program. So we intend to market to our students, but we also intend to help our students get some of those basic courses done first, so they can roll into the program that Galvanize runs on qualified basis. But yes, I think there's a synergy there that we can have many of our students who aren't going to go to college, or don't want to go to college who are looking for their careers. I think we can help them with exploration courses, and then we can help them with getting into the Galvanize as well.

Our next question comes from the line of Alex Paris with Barrington Research.

This is Chris Howe sitting in for Alex. Just congrats on the acquisition and the partnership with Galvanize. Some questions in regard to that. You mentioned the potential for re-skilling and up-skilling the workforce. Can you provide some more color on what you're seeing as far as the lifetime revenue of the student and the potential for them to go to Galvanize for initial training, enter the workforce? And then after 3 years, as software changes for them to reroute for additional training, is that an opportunity currently? Or how do you see that evolving?

Harsh, I think you are best prepared to answer that.

Yes, absolutely. I actually think that's one of the biggest opportunities for Galvanize, long term, down the road. Right now, the entire 8,000-plus and growing by over 1,000 every year base of alumni, we have not yet offered contained education programs or second time around programs to re-skill from a consumer perspective. But what is happening today is when those students enter into jobs, their managers may say, hey, where did you learn this modern stuff? And they'll reference Galvanize and Hack Reactor, and then that starts the conversation with that company or that enterprise for us to come in and re-skill their existing engineering talent. So from a -- there's 2 aspects to this. From a consumer perspective, that lifetime value is huge, and we have not yet begun to extract that for second time or third time consumer-based courses. But then the bigger, I think, lifetime value is when the enterprise engages through our consumer graduates, which actually could double, triple that lifetime value over time. Does that answer your question?

It does.

Yes. Before you go on, there's one other thing I want to add to that is, it sort of talked about how we put all of this together. We invested in a company called Tallo. They were up to a little over 700,000 students now. We are going to be working hard to put all 8,000 alumni here and all graduates on the Tallo platform. Now what that will allow us to do is track that alumni and track their skill, and so as they grow and as corporations see them grow, we want them to come back into the system and constantly get upgraded skills, and we'll be able to track when was the last time they got some skills. We'll be able to market to them and say, you realize there's some new technology you ought to be trained on and talk of those skills. So we'll be able to talk to those graduates through our talent platform as we get them on the platform. So that's another synergy in way of having continued education.

That's great. And my last question or series of questions. You mentioned some comments in the Q&A about the go-to-market proposition and the difference in value that you bring. Being a top 5 boot camp, what are you seeing as far as student mix, geographic trends? Are you seeing an increasing percentage of your students, I wouldn't call it transferring, or moving to your more elite boot camp from other competitors?

Harsh?

Yes. I'll be frank, I wish I could answer that with specific data off the top of my head, but I'll tell you more example-based. We do get students who either graduated or went through some other program halfway through or quarter of the way through and decided to change to come to Galvanize for data science or Hack Reactor to us for software engineering. That does happen. I'll be honest, I don't have the data to tell you whether it's increasing or at what rate. But as consolidation happens in this space, I expect it to continue to increase, especially because we continue to be focused on quality as our top-most metric. Does that answer your question?

Yes, that's good. All very helpful. And this is a lot of interesting things in front of me, but I'll hop back in the queue, and thank you for the color, and look forward to the combination.

Our next question comes from the line of Jeff Silber with BMO Capital Markets.

I also wanted to follow-up on Galvanize. You had mentioned in the prepared remarks about the use of income share agreement. And I know that's one of the things that Galvanize prides itself on. Is it possible to tell us roughly what percentage of students who use that and how that's been impacted in the market?

I don't know if everybody else understands what these income share agreements are. So Harsh, you can answer that. But first, I want to mention to everyone that the reason we think it increases the market is, Galvanize actually just started using income share agreements. So it's not -- it's not something that's driven growth in the past, which is why we believe it's a growth accelerator. Galvanize had just find an arrangement to have their ISAs funded. We think our cost of capital is lower than theirs, so we will probably renegotiate and develop a new set of ISAs that are even lower cost for us. So with that, I'm going to let Harsh answer, but I wanted to make sure everybody knew how we look at that as an accelerated, not as something they've been doing a long time. Harsh?

Yes, I'll double down on that. We just started broadcasting and publicizing ISAs more broadly, I want to say just a few months ago. And so our initial data, I believe, for our most upcoming cohort is going to be about 20% of the cohort using ISAs to fund their education. And like Nate said, we just started doing this. So we actually believe that it opens up an entire set of the market that, beforehand, wasn't open to us. So it's going to be additive to our enrollment, which is really exciting.

Okay. That's just -- forgive me, I guess, I've seen either something online or somewhere to think Galvanize was doing this, so I thought you're doing this for much longer. I appreciate that clarification -- I'm sorry, did you want to say something?

No, no. Go ahead.

Okay. Great. Going back to the combination of both companies, and forgive me, I came on late. Can you just repeat what you said about the path to profitability for this company? And you can give us a little bit more color in terms of how you're going to get there?

Yes, Jeff. So it's James. So what we expect is that we're going to exit our fiscal '21 with a profitable Galvanize subsidiary. And we're already seeing the early signs of growth in this calendar year, we see that growth continuing. The underlying business growth continuing through this calendar year into next year, which is going to drive that profitability exiting our next fiscal year. But as you know, the impact of -- the impact of purchase accounting will sort of mute that, particularly in the first sort of 6 or 12 months. So you're going to sort of see our financials will reflect something different. But then, again, as sort of that was -- some of that washes through and then on the adjusted EBITDA, exiting next year will be positive, our fiscal next year.

Yes. This is Nate speaking. This is going to be a little confusing because we haven't disclosed all the details around purchase accounting, but I would say this, the EBITDA, not adjusted operating income yet, but EBITDA will be positive for the full year of our fiscal year '21. The comments that James is making about the exit when you fall down to full operating income or EBIT, you're going to see some impact of obviously purchase accounting that shows up in amortization of goodwill and things like that, which will cause it not to be exiting in the year. But if you just look at the EBITDA, it's positive for the full year of our FY '21. So it's going to contribute to our EBITDA.

And is it possible to give us some kind of framework about the purchase accounting impact, both from a revenue perspective and an EBIT perspective?

Yes, I think it's -- right now, it's really early in the acquisition. As you know, there's some mechanics that we have to go through, but we will provide some updated guidance over the next couple of quarters. We just -- I think it's a little early for us, having just done the acquisition to give any guidance for it yet. But we will be before [indiscernible] next year? Yes, I'm sorry.

Last thing I will mention on that. From an operational perspective, I think it's important to understand that in the first 6 months that Galvanize is part of K12, we intend to remove the shackles, so to speak, from certain arms. They were working hard as a company that didn't have a lot of funding and they were tight on things like opening up new sites, they were tight on their marketing expenses. So we have said we don't mind in spending a little bit more money to open up new sites, spending more money to do a little more marketing to students and to do a little bit more development. So with those ideas, especially, by the way, there's an opportunity we have in the military market, which we didn't talk a lot about that they will work with military bases to retrain soldiers as well. And all of these things will require some money and investment in the first 6 months. So that's why we said it will be EBITDA-positive in fiscal '21, but for the next 6 months, we're going to let them spend a little bit money to get some of these revenue opportunities going. Does that help, Jeff?

Yes, it does.

Okay.

[Operator Instruction] Our next question comes from the line of Stephen Sheldon from William Blair.

For Galvanize's stand-alone financial performance, can you provide some detail on how quickly it's been growing in the past few years, the mix of online provided versus classroom-based revenue and maybe just some detail on stand-alone margin profile right now?

So Harsh, I think you should start with the mix question of online versus classroom?

Sure. So Galvanize has a couple online offerings. One is a full-time online, and the other is a part-time online. The former being about 3 months long and the latter about 9 months. So if you add up the revenue of both of those and compare them against the on-campus offerings, it's about -- it depends on the enrollment cycle. So it's roughly about 20% online, 80% on-campus.

And Harsh, how do you think that changes in the coming years?

I think the online enrollment continues to increase going up. And what we're finding is that a lot of students are loving the synchronous online offering. It really feels like you're developing really strong student relationships, which goes counter to typical assumptions about online education. And so we're -- we expect that to continue growing. Our most -- our incoming cohort that starts in a few weeks is going to be one of the largest ever for our online offering. So my expectation is that that mix will grow, while the overall pie will also grow.

To your other, I think, question around gross margin. The current mix of business as it's constructed today, and again, excluding the impact of any purchase accounting, has gross margins that are better than the current K12 gross margin by 10% to 20%. But with the mix that Harsh is outlining, changing over time. We obviously think that that gross margin profile will improve over time, but it's currently -- the mix is, in fact, better than the K12.

In terms of growth, your other question I think was what does the growth look like in the past. The growth in the businesses, the 2 segments have different growth profiles. The fastest-growing segment of the Galvanize businesses has been the enterprise business. It was the smaller of the 2, but it's definitely growing at a much higher rate than the consumer business. The consumer business is growing as well. But certainly, the enterprise business has been growing the fastest. And we don't disclose revenue growth rates of individual business units. I can tell you that the enterprise business will grow faster than the core business at K12 that's growing faster than the consumer business at Galvanize. It's the fastest-growing opportunity we see in the segment.

One thing I do -- just to add to the growth question, I think it's safe to say that, as Nate mentioned earlier, the Galvanize team was I think a little bit restricted in terms of what they could invest in for growth, whereas we won't be so restrictive, and we fully expect the Galvanize business to grow at a rate higher than we were expecting the overall K12 business to be growing, i.e., well into the double digits for years to come.

Got it. That's very helpful. And then I guess in the -- in kind of your core business, I just -- I guess on NPS student retention, how has that trended so far in fiscal '20 relative to your expectations, in both Career Readiness and regular NPS program?

This is Nate speaking. Without going into the gory detail, we tried something this year. And we talked a little bit about it on the call for the previous quarter. We talked about the fact that we changed the way we were marketing and the way we did enrollment. And what that -- we put a little more money into some things early on in the year. I think it -- the market was not expecting it. So it was part of our plan. The market probably didn't anticipate it. But what it did was it shifted the characteristics of our withdrawal and retention metrics. So we expected and we have seen greater withdrawals in the first half of the year. But it's sort of a washing out that happens that we expect through the rest of the year, retention will be slightly better than last year. So we expected to see more withdrawals early in the year and less withdrawals as the year goes on based upon the way we marketed to students and programs we put in place. So in terms of retention and how it's going, it's going largely flat with previous year but just with a different characteristic. We have seen, by the way, in the last 3 months, a tick up in retention, which is exactly what we expected to happen based upon the way we put our new market program in place.

Our next question comes from the line of Greg Pendy with Sidoti.

Just one, I guess, trying to get a grasp on the 85% placement rate. I assume as you try and embed some of the program into CTE, is that still going to be based on sort of end points, sort of exams-type thing types of outcomes? Or are you going to be able to use placement rates as well on that? Because my understanding was, under CTE, you were looking for things like Python certification as the outcome. So I'm just trying to understand because it seems like this is a much more intense program that already is going into the placement rate and sort of salary outcome?

Yes. If I got the question right, the answer will be, we don't expect the average person coming out of one of our programs at the high school level GCA programs to be able to be immediately qualified to move into a Galvanize program. The Galvanize program, you are right, is a more intense program at a higher level. However, the key here, for us, is to be able to take the Galvanize content and some of their entry-level courses because remember, I mentioned, when you go to apply to Galvanize, if you don't get in, they have recommended a number of entry-level courses you can take to get your skills strong enough that you can enroll in one of the immersive program. So we're going to take that content and make sure it's available at the high school level. And then once it's available at the high school level, that makes more of our students more qualified. Now sometimes, that may mean after they graduate high school, sometimes, they'll be able to do it, depending on their performance, while they're in high school. But we certainly think there is a step of learning that needs to happen between your average high school and before you get into one of these programs. And by the way there's a lifestyle change happened there as well. It's not just your intellectual intensity. It's also your life capacity because it's very immersive. It's very intense. And so you have to really be dedicated, much more dedicated than most high school students are going to be at this Galvanize level. So that's a gap that we'll have to bridge. And I think it's an opportunity for us quite honestly because it means we could take a number of high school students, and we can enroll them more in the lower-end courses, which means we can grow the revenue in the lower-end courses. Harsh, did I miss anything? Do you see that same way?

I do. Nailed it.

There seems to be no further questions up in the queue. And I'd like to turn the floor back over to you for any closing remarks.

This is Nate speaking. As always, I really appreciate those who attended the call. I appreciate the questions. And it's obvious that you were well engaged in what we were talking about, and I look forward to talking to you more about this. This is a very exciting time for K12, and I hope we will demonstrate to you that we can grow this business and grow our overall business. I think James also wants to make a closing comment. If I can, James?

Yes. I just -- we had -- I think because of the Galvanize transaction, we had a very large group of listeners today, much larger than we usually have. So I did want to sort of emphasize with any of the callers that if anybody has a follow-up question after this, do please contact Mike Kraft. I think his information on the press release we issued earlier today. So Mike would be available for any questions or follow-ups after this call.

Devin, back to you.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.